Robert Kuttner examines the factors that led to a healthy
economy and a relatively egalitarian distribution of income in the postwar
years. He then details the changes that
occurred from the 1970s to the present that altered the nature of the economy
to the extremely unegalitarian one we have today. He presents his thoughts in his book Can Democracy Survive Global Capitalism?
“The story of the lost social
contract of the postwar era has two essential elements. One was the liberation of finance; the other
was the undermining of labor.
Globalization was an instrument of both.”
Numerous examples are highlighted to support that
claim. Here we will focus on one that is
particularly noxious; one that illustrates the poisonous relationship between
the excesses of finance and workers’ welfare: the private-equity industry.
“The private-equity industry now
owns about 4.3 trillion dollars’ worth of operating companies that employ about
12 million workers.”
The practice at issue is what was once referred to as the
“leveraged buyout.” The maneuver
involves borrowing money to buy out the owners of a company (often
shareholders) and use the assets of the purchased company as collateral for the
extended credit. The private-equity
investors put up a small fraction of the required capital for the deal and load
the acquired company with the majority of the debt. The claim is that the new owners will make
the business more efficient and ultimately increase its value so it can be
resold at a profit at a later date.
However, making this process work leads immediately to the need to cut
expenses in order to service the newly acquired debt. The first cuts are inevitably in the number
of employees and their benefits.
“Private-equity companies have
even found legal ways of looting employee pension funds.”
The private equity investors protect their investment by
extracting assets up front to limit any risk.
“The truly nefarious aspect of
the private-equity business model is that windfall profits are extracted in advance, so that when the actually
operating company falters, the equity partners experience very little loss, if
any. This model turns on its head the
usual incentives to operate a business prudently and to view workers as
long-term assets.”
“Private-equity partners
accomplish this trick by borrowing heavily against a newly acquired company,
paying themselves an exorbitant ‘special dividend,’ as well as management fees,
that together typically far exceed the actual equity they have invested in the
company. They then move to aggressively
cut costs. If they succeed, they often
sell the stripped-down company to someone else.
If they cut too deeply, they’ve already made their fortune up front, and
they can use bankruptcy either to shut down the operation or to shed its debts
and restructure it.”
Bryce Covert produced an article for The Atlantic addressing the effect private equity is having on the
retail industry, with a focus on the recent Toys “R” Us bankruptcy. His piece was titled You Buy It, You Break It: How private equity is killing retail in
the paper version of the magazine.
Online, it ran as
Toys “R” Us was taken over by the private-equity outfits
Bain Capital and Kohlberg Kravis Roberts, and the real-estate firm Vornado
Realty Trust in 2005. A worker
immediately noticed a difference in working conditions.
“’It changed the dynamic of how
the store ran,’ she said. The company eliminated positions, loading
responsibilities onto other workers. Schedules became unpredictable. Employees
had to pay more for fewer benefits….”
When the company announced it would liquidating assets as
part of a bankruptcy process, all sorts of reasons were discussed by analysts
for why it was no longer able to compete in the current marketplace. One that was little mentioned was the burden
the private-equity takeover placed on the operation of the company.
“Less attention was paid to the
albatross that Bain, KKR, and Vornado had placed around the company’s neck.
Toys “R” Us had a debt load of $1.86 billion before it was bought out.
Immediately after the deal, it shouldered more than $5 billion in debt. And
though sales had slumped before the deal, they held relatively steady after it,
even when the Great Recession hit. The company generated $11.2 billion in sales
in the 12 months before the deal; in the 12 months before November 2017, it
generated $11.1 billion.”
“Saddled with its new debt,
however, Toys “R” Us had less flexibility to innovate. By 2007, according to
Bloomberg, interest expense consumed 97 percent of the company’s operating
profit. It had few resources left to upgrade its stores in order to compete
with Target, or to spiff up its website in order to contend with Amazon.”
Servicing the debt imposed on it by the private-equity
takeover left it with no funds to address changes required to keep up in an
evolving marketplace. Covert suggests
that as the reason for the demise of Toys “R” Us. And, of course, there were no funds left to
provide severance pay for the more than 30,000 employees who lost jobs.
Covert’s take on private equity is even harsher than Kuttner’s.
“Given private equity’s poor
track record in retail, it can be difficult to see what companies like Toys “R”
Us hope to get from a buyout. For private equity, however, the appeal is clear:
The deals are virtually all upside, and carry minimal risk. Many private-equity
firms chip in only about 1 to 2 percent of the equity needed for a leveraged
buyout, and skim fees and interest throughout the deal. If things go well, the
firms take a huge cut of the profit when they exit. If everything blows up,
they usually still escape with nary a burn. Toys “R” Us was still paying
interest on loans it got from KKR and Bain up until 2016, as well as millions a
year in ‘advisory fees’ for unspecified services rendered. According to one
estimate, the money KKR and Bain partners earned from those fees more than
covered the firms’ losses in the deal.”
Covert provides some data to illustrate private equity’s
impact on the retail industry as a whole.
“Toys “R” Us is hardly the only
retail operation to learn this lesson the hard way. The so-called retail
apocalypse felled roughly 7,000 stores and eliminated more than 50,000 jobs in
2017. For the spate of brands that have recently declared bankruptcy, their
demise is as much a story about private equity’s avarice as it is about
Amazon’s acumen.”
“In April 2017, an analysis by Newsday found that of the 43 large
retail or supermarket companies that had filed for bankruptcy since the start
of 2015, more than 40 percent were owned by private-equity firms. Since that
analysis, a number of others have joined the list, including Nine West,
Claire’s, and Gymboree. An analysis by the firm FTI Consulting found that
two-thirds of the retailers that filed for Chapter 11 in 2016 and 2017 were
backed by private equity.”
This behavior has aroused some pushback by activists, but
enormous profits provide enormous political influence.
“A conglomeration of
workers’-rights and financial-reform organizations is seeking to outlaw
leveraged buyouts altogether. ‘They weren’t always legal,’ Charles Khan of the
Strong Economy for All Coalition, which is part of the group, points out.
Before the 1980s, companies couldn’t finance deals with such high levels of
debt. One aim of Khan and his allies is to once again force buyouts to rely on
a smaller portion of debt. ‘The economy has existed long before private equity,’
he says. ‘I think it can exist without private equity’.”
Robert Kuttner provides an appropriate comment with which
to close.
“The losers in these maneuvers are
invariably the workers. They lose wages,
benefits, pensions, or their jobs.
Private equity is just one more strand in a complex tapestry of degraded
work. Ordinary workers may not grasp the
complex strategies, but they surely understand the results. Why is this legal? How can private-equity companies get away
with these moves? They invest heavily in
political influence. The result, as
someone said, is that ‘the rules are rigged’ against working people.”
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